Supply and demand are simple enough and markets work to clear at “competitive” prices. This means that as demand for electricity increases so does the price, all else equal.

by Alex Frank

Supply and demand are simple enough and markets work to clear at “competitive” prices. This means that as demand for electricity increases so does the price, all else equal. To meet rising demands, especially at peak times, electricity markets call on more expensive generating units or demand response (often paid the clearing price) that are willing to meet load at higher prices. This ensures an adequate supply of power and continued reliability but also means that electric utilities typically face the highest cost for electricity during summer months, when the weather is hot and humid and the air conditioning load is high. This peak demand not only drives cost but also utility investment in distribution infrastructure and, in some cases, demand response. 

On the surface, the Clean Power Plan (CPP) appears to have little to no effect on this process. One of the results of the CPP may be to simply change the mix of generation resources available for purchase through the growth of natural gas generated electricity but it wouldn’t appear to affect the market mechanism. Yet, the rise in prominence of natural gas electric generation may have an unforeseen effect on these markets. Natural gas, of course, is also a key source of heating across the country and as the demand for natural gas rises in the electricity sector the overall demand for natural gas during winter months also rises. 

The current relative abundance of natural gas would appear to limit the price effect of the increased demand, but the supply of natural gas to end users is not just dependent upon the amount of natural gas that can be extracted, but the amount that can be transported to end-users. The transportation capacity for natural gas is fixed, unless new pipeline or storage facilities are built. This rising demand for natural gas combined with limited deliverability will lead to rising natural gas prices. Electric utilities in the northeast have already experienced this, facing the highest cost for electricity not during the months of high electricity demand (summer) but in the months with the highest natural gas demand (winter). 

As price increases there will be greater incentive to build additional natural gas transportation capacity and the market will, ultimately, clear. But, building new pipeline capacity is not a quick process and there could be years of imbalance where utilities must not just keep an eye on the electric market, but also the natural gas market. As electric utilities become price takers in the natural gas market they may look to get more involved to protect themselves and their customers. Recently, Southern Company bought AGL resources, which could be a sign of this exact outcome. This further highlights the paradigm shift underway as States and Markets begin to grapple with the effects of the CPP. Balancing the social, environmental, and economic needs of the energy industry are increasingly challenging and the CPP and its effects on the natural gas supply market are just another example of the deep interconnections of all the components of these markets. Electric utilities, whether they like it or not, are often at the center of this issue and have a unique opportunity to take a leadership role to help regulators understand these types of consequences.